Despite the worries of
some economists, America’s record foreign debt is no threat to the nation’s
economic well-being.

Edwin S. Rubenstein

In 2000 we
Americans bought $368 billion more goods and services from other countries than
we sold to them. This trade deficit has rocketed tenfold since 1992 and is
universally seen as a sign of economic strength. As consumers in the largest
and strongest economy in the world, it’s hardly surprising that we routinely
buy more from other countries than they buy from us.

But the “flip
side” to our burgeoning trade deficit has many people spooked. Every dollar
that goes abroad eventually flows back to the United States, enabling
foreigners to buy valuable economic assets. Foreigners now own over $8.6
trillion of U.S. assets (93 percent of gross domestic product, or GDP), up from
$725 billion, or 22.2 percent of GDP, in 1982 (see table). Since 1998, foreign
companies have been acquiring U.S. companies at a pace that brings back
memories, and anxieties, of twelve years ago when Japanese investors were
gobbling up U.S. real estate.

In recent years,
Mercedes bought Chrysler, the Deutsche Bank took over Bankers Trust, the
international activities of RJR Tobacco (Camel cigarettes, among other brands)
were purchased by Japan Tobacco, and a Dutch supermarket firm, Royal Ahold,
bought a New York supermarket chain, Pathmark, comprising 132 stores. Earlier
this year the Netherlands media company VNU announced that it had completed its
$2.3 billion acquisition of American market research giant ACNielsen. Nestlé is
trying to obtain Federal Trade Commission approval to acquire Ralston Purina,
and the U.S. NASDAQstock exchange may
become a target for the London and Frankfurt exchanges.

That’s only a
sample. Foreign companies have spent $900 billion in the past three years
buying U.S. companies, while U.S. companies have spent $419 billion buying
foreign companies, according to Thomson Financial Securities Data. That is a
significantly greater spread than during the rest of the 1990s.

Foreigners also
own a record 38 percent of the U.S. Treasury market (see fig. 1). Excluding
securities owned by the Fed, foreigners own an astounding 44 percent of the
liquid government securities market. They also own a record 20 percent of the
U.S. corporate bond market. To put these figures in perspective, foreigners own
just 8 percent of the U.S. equity market (see fig. 2)—14 percent if you include
foreign direct investment in U.S. companies. Simply put, the American bond
market will be on the front line if international investors decide to shun
dollar-denominated assets (see fig. 3).

Buying the Knowledge

The inflow of
foreign capital is the unsung hero of America’s impressive economic performance
in recent years. Foreigners’ willingness to send money to the United States has
lowered bond yields and provided fuel for the massive investment and
consumption spree that has propelled the American economy to record heights.
Americans who work for foreign-owned companies typically make 10 percent more
than those who work for U.S.–owned companies, reflecting the larger relative
size and productivity of multinational corporations. Today approximately 20
percent of the U.S. GDP is produced in companies with majority foreign
ownership.

Could a darker scenario
unfold? The U.S. current account deficit increased to a record 4.4 percent of
GDP in 2000, up from 3.6 percent in 1999. This trend worries international-trade
economists, many of whom think that economies typically hit the breaking point
at 4.2 percent of GDP. Indeed, the current account deficit could be the chink
in America’s economic armor: were foreigners at the margin to become less
willing to send capital here on favorable terms, interest rates would rise and
the dollar would fall. That would be more bad news for the stock and bond
markets.

But are the traditional “breaking points”
relevant today? Not if foreigners believe that the U.S. economy is pulling away
from the rest of the world (as it has) or that (1) America has the only economy
large enough to absorb their investment dollars and (2) our productivity lead
over the rest of the world is still growing, which it is. Foreigners have grown
convinced that the mature U.S. economy can grow more rapidly than the
traditional 2 to 3 percent annual rates without causing inflation. The
consensus is that foreign companies have grown convinced that their U.S.
competitors are so far ahead in digital, biotech, and other new technologies
that the only way to close the gap is to buy the knowledge. That means buying
the company.

And despite the
recent slowdown, the sheer size and depth of the U.S. economy mean that the
United States will continue to be the destination of choice for foreign
investors.

In the world of
national economic accounting, however, foreign purchases of U.S. companies,
real estate, and securities are counted as “borrowing” from abroad.
Accordingly, the United States has become the world’s largest debtor. As a
result of twenty consecutive years of external deficits, the United States has
shifted from a net creditor nation of $350 billion in 1980 to a net debtor of
$1.7 trillion in 2000. Critics worry that interest, dividend, and other service
payments on the external debt represent a perpetual drag on the U.S. economy
and a burden on future generations of Americans.

Much of what
foreigners invest in the United States, however, cannot realistically be
described as any kind of debt on American citizens. Almost half of the $8.7
trillion in foreign-owned assets at the end of 1999 was in the form of equity
investments—either long-term direct investment in U.S. corporations and real
estate or portfolio investment in corporate stock. Such investments are not
debt in the sense of an obligation to pay a fixed amount no matter what. When a
German company buys an American automaker, or when Japanese investors buy U.S.
real estate, or when a British company adds 100,000 shares of Microsoft to its
portfolio, no American is under any legal obligation to repay anything. On the
contrary, equity investors receive only what the market says they should
receive. They are hostage to the good fortune of the U.S. economy and have a
strong incentive to keep it healthy.

Moreover, the size of America’s overall
international investment is not alarming when compared to the total U.S.
economy. At the end of 2000, America’s net foreign debt of $1.87 trillion
represented approximately 18.8 percent of that year’s GDP. In other words,
Americans were producing enough every ten weeks to buy back the difference
between what foreigners own in this country and what we own abroad. Our debt
service payments are also quite modest as a percentage of the overall economy.
In 2000 Americans paid $359.1 billion in dividends and interest to foreign
investors and received $345.4 billion from U.S. investments abroad, for a net
payments deficit of $13.7 billion. As a share of what we produce, the payments
deficit amounted to less than one-fifth of 1 percent of GDP. That’s equivalent
to a family earning $75,000 per year paying creditors $103.

Shared Destinies

A second,
persistent worry is that growing foreign ownership of U.S. assets will leave
America vulnerable to foreign influence and manipulation. The fear is that
America’s principal creditors, Japan in particular, could wield influence over
U.S. government decisions by threatening to sell their U.S. government bonds or
to cease further purchases.

It is true in theory that foreign governments
could attempt to exert political pressure on the United States by threatening
to sell their large central-bank holdings of U.S. Treasury debt, but such an
act would harm their own economies as well. Americans would lose, of course,
because a withdrawal of capital would drive up domestic interest rates while
the falling dollar would make imports more expensive, which would reduce the
purchasing power of American workers. But America’s creditors would suffer if
their alternative investments were less profitable. Foreign investors would be
further harmed if the U.S. economy were to tip into a recession. Falling demand
in the United States would quickly translate into falling exports to the U.S.
market, and a depreciating U.S. currency and slumping economy would depreciate
the value of foreign-owned assets remaining in the United States.

The
foreign-influence scenario also assumes that individual investors would follow
the lead of their governments, but such an orchestrated withdrawal of credit
seems unlikely. Private investors in industrialized countries do not usually
act at the behest of their governments. Even in Japan, a government decision to
dump dollars or withdraw funds from U.S. markets would not mean that private
companies and individuals would necessarily do likewise.

The fact is, when
foreign investors act precipitously and in unison, they usually end up losers.
For example, Japan charged into U.S. real estate in the late 1980s, just in
time to pay top dollar for properties such as the Rockefeller Center. And when
Deutsche Telekom proposed a $51 billion acquisition of VoiceStream at the peak
of the U.S. stock market last year, Telekom shares dropped because investors
feared that European companies were overpaying for U.S. firms.

When an economy is as large and as important to the
global economy as is that of the United States, its chief creditors have a
stake in keeping it healthy. They have a strong incentive to act prudently with
their investments so as not to undermine their own positions. If any country
wields leverage, it is the world’s chief debtor, the United States.